Israeli shipping carrier ZIM Integrated Shipping Services (NYSE:ZIM) enjoyed a stellar two years on the back of soaring ocean freight rates and their strategy of rapid capacity expansion. With both earnings drivers normalizing, however, their earnings prospects look weak and although their dividend yield of 176% makes the company very attractive, this is not likely to be sustainable and reduced dividends may exert downward pressure to their share price resulting in potentially steep capital losses as well.
Slumping spot container rates plus possible overcapacity
A pandemic-induced supply chain bottleneck over the past two years drove demand for containers as well as freight rates which reached all-time highs. ZIM’s capital-light business model (unlike bigger players who charter roughly half of their fleet, ZIM’s chartered ships account for more than 90% of its fleet according to latest data from Alphaliner) allowed the company to rapidly expand its fleet and make blockbuster profits during the pandemic on the back of soaring freight rates. Both of these earnings drivers however are turning south; freight rates are collapsing and are returning to pre-pandemic levels as a result of normalizing supply chains and easing port congestion alongside a reduction in consumer spending driven by a tighter monetary policy. Freight rates for a 40-foot container from China to America’s west coast have sunk more than 80% from its peak of USD 20,600 in September 2021 to USD 1,400 currently according to Freightos, an online freight marketplace. With inflation and rising interest rates crimping consumer spending, and supply chains on the mend, the days of sky high freight rates and super-sized earnings for shipping carriers are likely over for the time being. The issue is more pressing for ZIM in particular who has a greater exposure to spot rates (as high as 50% versus around 30% for larger rivals Maersk).
Not only are rates dropping, but falling demand and normalizing supply chains means easing port traffic, and therefore shorter transportation time which means a release of a significant number of containers.
Container volumes have been declining for several months and the Baltic and International Maritime Council (BIMCO) expects 2023 growth prospects to remain weak after a forecast 4% YoY decline in container volumes in 2022. Maersk echoes a similar view expecting cargo demand to remain weak after Chinese New Year. ZIM has already axed some trans-pacific routes (trans-pacific routes are ZIM’s most popular routes and is ZIM’s biggest revenue generator) which became uneconomical to operate due to slumping rates and now faces the challenge of redeploying those chartered vessels to alternative routes.
Coupled with additional TEU to be delivered (BIMCO expects global fleet growth of 8% in 2023), the global shipping industry appears to be headed towards a down cycle with excess TEU, and potentially a price war to boot as players battle to support vessel utilization.
Mediterranean Shipping Co, the world’s biggest container line with a total capacity of 4.5 million TEU has an orderbook of 124 vessels with a total capacity of 1.7 million TEU amounting to nearly 40% of its existing fleet. Maersk, the number two player with a total capacity of 4.2 million TEU has an orderbook of 31 ships 376,400 TEU. CMA CGM, the third largest player with a capacity of 3.4 million TEU has an order book of 7 vessels for 660,495 TEU. COSCO Group, the fourth largest player, has an orderbook for 884,272 TEUs. Hapag-Lloyd has an orderbook for 362,544 TEU and sixth-ranked Evergreen Line has an orderbook for 465,918 TEU. ONE, the world’s seventh largest shipping carrier with a capacity of 202 ships for 1.5 million TEU has an order book of 30 ships with a capacity of 418,430 TEU.
ZIM meanwhile has the highest fleet growth among the top ten players with an order book of 43 vessels for 378,034 TEU representing 70% of its existing fleet (all ships in its orderbook are procured through charters). Although this appears concerning given deteriorating trading conditions, with 25 and 37 vessels up for renewal in 2023 and 2024 respectively, the company has levers to adjust its fleet size to accommodate the 43 new vessels expected for delivery in 2023-2024.
Nevertheless, a combination of overcapacity, sagging ocean shipping rates and a looming recession suggest choppy waters ahead. Japanese ocean carrier ONE expects profits to contract by 60% for the six months to March 2023 as trading conditions deteriorate for global shipping carriers.
ZIM is not likely to be spared and going forward, barring any unforeseen improvements to ocean shipping rates or cargo demand, the company’s profitability may resemble that seen before the pandemic (which was mostly negative or barely above break-even), which in turn suggests a very likely reduction in dividends (the company aims to pay 30% of earnings as dividends but as earnings drop so will dividends in absolute amounts although the company’s 30% dividend payout policy may not change). A drop in dividends may exert downward pressure on the stock price as well and investors may be left with a smaller dividend (or possibly nothing at all if the company turns unprofitable), and possibly a capital loss as well.
ZIM is in considerably better shape and better managed than years ago when the company nearly went bankrupt. Apart from the financial and operational advantages that come with a lean, asset-light business model, company management is proactive, with plans to blank sailings, redeliver charters, and optimize its network to cut costs. ZIM is financially in a decent position at the moment with about USD 3.6 billion in cash, USD 1.2 billion in receivables and USD 2.7 billion in current liabilities and virtually no debt and is thus better prepared for any anticipated operating challenges. The industry may go through another round of consolidation, but ZIM which was seen as a potential takeover target a few years ago is now unlikely to come under the radar of bigger players again despite looking increasingly attractive for a strategic buyer with a current market capitalization of USD 2 billion which is less than their cash balance of USD 3 billion and way lower than their shareholders’ equity of USD 5.8 billion at the end of September 2022. News of a potential takeover could have been a catalyst to spur ZIM’s stock price but Israel’s Special State Share in ZIM restricts shareholders from taking over the company, and with this possibility not available the stock price is likely to remain depressed barring any changes to this restriction.
After a 70% YTD drop in their share price, ZIM now offers a 176% dividend yield (before accounting for 25% withholding taxes) a 0.46 P/E, and a market capitalization that appears to be lower than their liquidation value (market capitalization of USD 2 billion versus September 2022 shareholder’s equity of USD 5.8 billion) indicating a very attractive price, particularly for a strategic buyer. ZIM’s ownership structure has an anti-takeover effect however so ZIM is not likely to find any interested buyers who could serve as a catalyst to lift their falling stock price.
As a going concern however, with their two key earnings drivers – capacity growth and spot rates – both turning south, a trajectory not likely to reverse, the company’s earnings prospects look pessimistic and may possibly remain depressed for years, and therefore their dividend may not be sustainable and this in turn may affect their stock price going forward potentially resulting in a steep capital loss.
Analysts are mostly neutral on the stock.